I am probably just reading this wrong but this question and answer don’t seem to fit to me… Suppose an analyst uses the statement of cash flows to calculate free cash flow to the firm (FCFF) as cash flow from operations less fixed capital investment, and free cash flow to equity (FCFE) as FCFF plus net borrowing. The firm has short and long term debt on its balance sheet. Has the analyst correctly stated, overstated, or understated FCFF and FCFE? A:Overstated, Correct B:Understated, Understated C:Understated, Correct The book says the answer is C. I understand why FCFF are understated because [Int(1-T)] was left out of the equation and should have been added back in…in the explanation of the answer it goes on to say that “he has, however, calculated FCFE correctly because FCFE is equal to CFO less fixed capital investment (his incorrect FCFF calculation) plus net borrowing.” FCFE=FCFF-[int(1-T)]+net borrowing. what am I missing? Edit: After typing this out, and re-reading the question several times, the only conclusion I can come to is that if I view the equation as what the analyst computed within the parameters of the question, and not view the question with an absolute perspective… If the analyst left out [Int(1-T)] in the first place then his calculation of FCFE would be correct even though he used an incorrect formula…if that is so, this is a pretty sneaky f***ing question…
Your edit is correct.